Livestock Risk Protection

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					Livestock Risk Protection
                         Overview

Ø Livestock Risk Protection (LRP) insurance is a single-peril
  insurance program offered by the Risk Management Agency
  (RMA) if USDA through commercial crop or livestock
  insurance vendors.
Ø An LRP policy protects producers from adverse price changes
  in the underlying livestock market.
Ø LRP is currently available in all counties of 37 states.
                         How LRP Works
Ø A producer must submit an LRP policy application through an
  authorized crop or livestock insurance vendor.
Ø Insurance vendors must have completed an RMA training program
  to become authorized.
Ø The application process establishes a producer’s eligibility by
  documenting his or her substantial beneficial interest in the cattle.
  A producer with a partial interest in a group or pen of cattle may
  independently insure his or her portion.
Ø After completing the policy application, producers select a
  coverage price and endorsement length that meets their risk
  management objectives.
Ø The coverage price is a percentage of the expected ending value.
  This value and the associated rates are based on the current day’s
  closing futures prices, volume and volatility; they correspond to
  separate endorsement lengths.
                  How LRP Works cont.
Ø Endorsement lengths are in increments of about 30 days from
  13 to 52 weeks. Both feeder cattle and fed cattle producers
  will want to purchase price risk insurance with an ending date
  of coverage that meets their risk management objectives.
Ø Feeder cattle producers may want the end date of coverage
  to match the expected date the cattle will be sold or moved
  to a feedlot.
Ø Fed cattle producers, on the other hand, will want to match
  the ending date of coverage with the anticipated date the
  cattle will be ready for slaughter.
                     How LRP Works cont.
Ø LRP coverage does not begin until a Specific Coverage Endorsement (SCE)
  is submitted and accepted by RMA. The submission of the SCE to the RMA
  is done online after the application has been accepted. The SCE specifies
  the elected coverage price, the specific number of head covered, and the
  length of coverage.
Ø LRP policies require that sales be allowed from the time rates are set and
  validated to 9:00 a.m. Central time the following day. Once the SCE is
  accepted, the coverage is in place and a premium is due. If, at the ending
  date of coverage, the Actual End Value has dropped below the selected
  coverage price, the producer can claim an indemnity but must file for it
  within 60 days. The indemnity will be paid whether or not the cattle were
  sold by the ending date of coverage. However, selling the cattle more
  than 30 days before the end of coverage will terminate the policy unless
  the insurance provider has specifically approved the sale. Cattle seized,
  quarantined, destroyed or not salable because of death or disease will still
  be covered by the policy if written notice of the circumstances is provided
  within 72 hours.
                  How LRP Works cont.
Ø It is crucial for producers to understand that the ending value
  of the LRP contract is not the cash price received or a closing
  futures price as of the end date of the policy.
Ø The LRP-Feeder Cattle policy uses the Chicago Mercantile
  Exchange feeder cattle price index as the actual end value.
  This cash-settled commodity index is a mathematical
  calculation that averages the headcounts, weights and prices
  from numerous livestock sales across the nation to determine
  its settlement price.
Ø The LRP-Fed Cattle policy uses a weekly weighted average of
  the slaughter cattle prices in five areas as reported by the
  Agricultural Marketing Service.
                    Contract Specifics

Ø Feeder cattle policies insure all feeder cattle weighing up to
  900 pounds. They will cover heifers and Brahma and dairy
  breeds. A fixed percentage price adjustment factor (PAF) is
  used to adjust the expected ending values and coverage price
  from standard weight, beef breed feeder cattle for various
  combinations of lightweight heifers or non-beef breeds.
Ø LRP-Fed Cattle policies provide coverage for fed cattle that
  will weigh 1,000 to 1,400 pounds at slaughter.
                  Table 1. Key LRP Web sites

                       LRP agent locator     http://www3.rma.usda.gov/apps/agents/

                    LRP premium locator      http://www3.rma.usda.gov/apps/premcalc/

 Endorsement lengths, coverage prices,       http://www3.rma.usda.gov/apps/livestock_reports/m
                                             ain.aspx
                  rates and end dates
                CME Feeder Cattle Index      http://www.cme.com/trading/dta/hist/cash_settled_
                                             commodity_prices.html
AMS five-area, weekly weighted average
                                             http://www.ams.usda.gov/mnreports/lm_ct150.txt
               for direct slaughter cattle
   Table 2. Price Adjustment Factor for LRP-Feeder
                   Cattle Contracts

Weight range      Steers   Heifers   Brahman   Dairy
     <6.0 cwt.    110%     100%       100%     100%
 6.0 – 9.0 cwt.   100%      90%       90%      80%
  Table 3. Contract Specifics for LRP-Fed Cattle and
             LRP-Feeder Cattle policies
                                 LRP-Fed Cattle              LRP-Feeder Cattle
                            Yield Grade 1 to 3, 10 to       Heifers and steers,
    Insurable Cattle                14 cwt.                    Up to 9 cwt.
      End value based on     5-area weekly weighted
           (revised daily) average for slaughter cattle   CMW feeder cattle index
                               as reported by AMS
 Authorized endorsement          13 to 52 weeks               13 to 52 weeks
                  length
         Coverage Levels           70 to 100%                   70 to 100%
        Premium subsidy                13%                         13%
   Maximum head insured               2,000                       1,000
                per SCE
Maximum insured per crop              4,000                       2,000
                    year
    Example 1. LRP-Feeder Cattle for a West
          Texas Cow-calf Producer

In mid-October, the owner of a 340-head cow-calf operation is
buying an LRP-Feeder Cattle policy for his current calf crop. The
calves are typically weaned (88 percent calf crop) about September
15 each year and carried over to the middle of January before the
producer decides whether to market them, retain ownership for
additional winter grazing, or move them to a feedlot. It is
estimated that by mid-January the steer calves will average 700
pounds and the heifers will average 650 pounds. Coverage will be
purchased on all of the heifers, including those that will be
retained as replacements. This producer has no partners and owns
100 percent of the calves. This producer will use actuarial data
from the RMA on October 15, 2007, which is shown in Table 4.
Table 4. LRP Expected End Values, Coverage Prices, Levels, Rates,
          and Contract End Dates for October 15, 2007


 Livestock     Expected    Coverage   Coverage             Cost per
    type       end value     price      level     Rate      Cwt.       End Date
      Steers   $113.819    $107.97     .9486     .014411   $1.556     01/14/2008

     Heifers   $102.437     $97.17     .9486     .014411    $1.40     01/14/2008
                     Table 5. The Insured Value Calculation
  (The Insured Value = Number of Head multiplied by the Target Weight (live
weight, in cwt) multiplied by the Coverage Price multiplied by Ownership Share.


  Number of        Target weight        Coverage price          Insured                Insured
 head (whole   X     at end date    X    (as shown on    X       Share             =    Value
   number)         (cwt per head)           Table 4)            (x.xxxx)                  ($)
  150 steers   X     7.00 cwt       X      $107.97       X        1.00             =   $113,369

 150 heifers   X     6.50 cwt       X      $97.17        X        1.00             =   $94,741

                                                             Total insured value   =   $208,110
          Table 6. The Total Premium Calculation
(The Total Premium = Insured Value multiplied by the Rate)


      Insured value         x           Rate              =   Total premium
           ($)                  (as shown in Table 4)               ($)
Steers           $113,369   x         .014411             =      $1,634

Heifers          $94,741    x         .014411             =      $1,365

                                          Total premium   =      $2,999
              Table 7. The Subsidy Calculation
(The Subsidy = Total Premium multiplied by the Subsidy Rate)


Total premium   X      Subsidy        =          Subsidy
      ($)             (percent)                    ($)
   $2,999       X       .130          =           $390
        Table 8. The Producer Premium Calculation
(The Producer Premium = Total Premium minus the Subsidy)



Total Premium   x     Subsidy       =     Producer Premium
      ($)               ($)                      ($)
   $2,999       x      $390         =          $2,609
                       Indemnity Calculation
Assume that on the end date of coverage, the CME feeder cattle index has dropped to
$103.50 per cwt. Since the actual ending value is less than the coverage price ($107.97 -
$103.50 = $4.47), an indemnity is due the producer on the insured steers. The PAF for
heifers is applied to the actual ending value ($103.50 x 90% = $93.15). Again, an indemnity
is due on the heifer calves ($97.17 - $93.15 = $4.02). The indemnity is equal to the number
of head multiplied by the target weight (in cwt as defined in the specific coverage
endorsements), multiplied by the difference between the coverage price and the actual
ending value (in dollars per cwt), and then multiplied by ownership share (percentage).
                   Table 9. Indemnity Calculation


 Number of    x    Target weight at   x   Coverage price minus   x    Insured          =
head (whole       end date (cwt per        Actual ending value         Share               Indemnity
  number)               head)                                         (x.xxxx)                ($)
 150 steers   x       7.00 cwt        x          $4.47           x      1.00           =    $4,693

150 heifers   x       6.50 cwt        x          $4.02           x      1.00           =    $3,919

                                                                     Total indemnity   =    $8,612
         Attractive Attributes of LRP Policies

Ø The fact that policies will be sold at the rates ($ cost per cwt)
  quoted on the RMA website will appeal to producers who
  have tried to purchase a CME put option but failed because of
  light trading on that particular day or simply not being able to
  get an order placed and filled at the desired price.
Ø LRP policies can be tailored to fit producers of different sizes.
Ø The subsidized premium of an LRP policy may also appeal to
  producers.
                 Disadvantages of LRP Policies

Ø LRP is basically an insurance policy. Once this policy has been
  purchased and is in place, it cannot be offset or exercised until the
  end date of coverage.
Ø Local basis risk is still an issue facing producers who use LRP
  policies. Increased investor interest in the commodity markets may
  be widening local basis and making it less predictable. The
  difference in basis is not likely to increase the utility of LRP to Texas
  producers.
Ø Feeder cattle producers who want to buy coverage at the same
  time cattle are purchased and producers who want to buy LRP
  coverage at the most distant end dates of coverage may find their
  choices of coverage prices limited.
Ø RMA also retains the right to suspend the sale of LRP policies if the
  market becomes unstable.
                          Summary
Ø LRP is an insurance tool that may help with risk management
  role once a producer identifies his risk management
  objectives (risk tolerance, cost parameters, etc.) and
  understands the limitations of LRP.
Ø Producers will need to learn to evaluate LRP in comparison
  with other risk management strategies that use CME futures
  and option contracts at different periods in the production
  cycle.
Ø LRP policies are intended to insure against a drop in the
  underlying livestock market.
Ø LRP policies also do not guarantee a cash price or basis level
  for the local market.

				
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